At the end of 2017 and the beginning of 2018, ICOs and newly created Ethereum tokens were making the biggest headlines in the cryptocurrency space, asides from Bitcoin. But those days are now gone. New technologies have stepped up to take their place. Decentralized finance and DeFi protocols have taken over the blockchain industry and given birth to yield farming.
This innovative new approach to profit-making is based on smart contracts and has already earned early investors incredible capital gains. But what is yield farming, and can I profit from it short term? In our guide, we will explain what you can do to put your cryptocurrencies to good use and return high yields.
What is Yield Farming?
Yield Farming is also known as liquidity mining. It involves earning capital gains by allocating your cryptocurrencies to various liquidity pools and DeFi protocols. The users can lend or borrow DAI, USDT, USDC, Ethereum, and several other assets from different DeFi platforms.
The users who invest their funds are known as yield farmers, and they become liquidity providers to DeFi projects. Some liquidity pools provide a fixed rate, while others offer a variable rate on user investments.
The easiest way to become involved with and have success in yield farming is by lending, borrowing, and trading on the most popular DeFi platforms in the space. That is the way to achieve higher yields and bigger rewards.
Which DeFi protocols Offer the Biggest Yield Potential?
Defi Pulse has created a nifty site that tracks the most widely-used platforms and shows the total value locked in these smart contacts. There is currently over $6.5 Billion worth of digital assets locked in 38 global DeFi projects.
Investors are drawn to these sites due to the incredible profits they can make. Even centralized exchanges, like Coinbase, are trying to get a piece of the action by listing DeFi tokens, such as the COMP token, on their platform.
Among the best-known brands we can find:
MakerDAO
Uniswap
Compound Finance
Balancer
Synthetix
InstaDApp
Aave
Curve Finance
WBTC
Compound Finance
This is a major DeFi project for decentralized lending and borrowing of cryptocurrencies. Compound Finance has 9 different markets. Its TOP 3 markets involve the stablecoins DAI and USDC, but the Ethereum market is also significant. The protocol has its own native currency called COMP Token.
Lenders can participate in the yield farming ecosystem by earning a return on the funds they deposited with Compound. But that is not all. Lenders and borrowers are additionally rewarded with COMP tokens every day.
The more a user lends or borrows, the more COMP Tokens he will receive as an award. Early users were able to take advantage of this and earned interest rates of up to 100% APY. These tokens are precious and are valued at around $200 on CoinMarketCap. They can be sold on cryptocurrency exchanges for additional profits.
The Uniswap DEX and Liquidity Pool
Uniswap is a decentralized exchange (DEX) and one of the biggest liquidity pools in the DeFi niche. These pools allow users to unify their assets at the same place and become liquidity providers. The tokens in the Uniswap pools are then used to make swaps with other users.
Each pool consists of only two tokens, which have to be supplied at a 50-50 ratio. Each time a swap deal is carried out involving the coins from a liquidity pool you contributed to, every liquidity provider earns a fee. The value of these fees will depend on the number of deposited assets to the Uniswap pool. Yield farming through Uniswap has proven to be quite profitable over the past couple of months.
The Balancer DeFi Liquidity Protocol
Balancer is another liquidity pool, and DEX similar to Uniswap. But with a few essential modifications. A Uniswap pool consists of only two crypto-assets while Balancer allows pools with up to 8 different cryptocurrencies. The ratio can be customized to fit the needs of the user. Yield farmers earn interest by collecting fees on completed trades by other users on the platform.
Balancer has taken advantage of Compound’s business model and rewards its DeFi users with their proprietary token, BAL.
Synthetix – the Original DeFi Incentives Pool
The Synthetix protocol was the project that first introduced incentivized rewards and introduced the community to yield farming. In July 2019, they offered their SNX tokens as incentives to users who added liquidity to their sETH/ETH pool on Uniswap. It became one of the biggest active pools.
The SNX contract has expired, and users are no longer being awarded over Uniswap. However, Synthetix still has a vital role in the yield farming business. It has two active pools on the Curve Finance protocol.
Can I use DeFi with Bitcoin?
That is also possible thanks to an Ethereum-based ERC-20 token known as Wrapped Bitcoin (WBTC), which is tied to its underlying asset (Bitcoin) to a 1:1 ratio. The newly created token can be deposited on Compound or Curve to earn capital gain and higher yield.
The bottom line is that yield farming has also made it possible for the oldest blockchain asset to be part of the new trend.
Are There Any Risks Associated with Yield Farming and the DeFi Niche?
Yes, there are. Investing in volatile financial markets, such as the crypto market, always bears certain risks. The same principles apply to DeFi.
The most significant known risks are associated with smart contract vulnerabilities. These protocols are based on open-source software. Hackers and exploiters can inspect the code in search of weak spots that could be exploitable.
Unpleasant attacks have been recorded a few times already. During two incidents, hackers were able to take out significant loans without providing collateral. A different type of drama happened in March 2020 after the value of Ethereum crashed. This resulted in MakerDAO loans to be liquidated and millions of dollars’ worth of losses.
Then there are questions about the authenticity of the number of locked funds and their value. Compound Finance states, for example, that over $600 Million worth of DAI is locked on their platform. But how can this be correct if the circulating DAI supply is $400 Million!? The reason for this is that the same coins are being loaned and borrowed over and over again.
Conclusion
Yield Farming is the newest attraction in the world of DeFi. In this article, we have mentioned many protocols that reward its investors for allocating their capital. Our suggestions shouldn’t be considered bulletproof financial advice, but a general overview of what is available on the market.
Yield Farming and liquidity mining can be very profitable. But the investors need to consider the current state of the Ethereum blockchain and the high gas prices associated with token transactions. Yield farmers can find themselves in situations where they need to transfer their funds between different platforms to achieve higher yields. Investing too small amounts could result in losses when all fees have been deducted. On 13 August 2020, ETH transaction fees reached $7 per transaction, mostly due to the activity on DeFi platforms.
There are plenty of options out there. Lending your assets to a business venture such as Compound Finance results in decent returns. There is also the added incentive of receiving COMP Tokens for your work. Pooling your funds together on Uniswap and Balancer and earning a share of the fees is another option.
Whatever protocol you end up using, make sure you have done thorough research on its track record and the yield potential it offers. DeFi protocols will get better, safer, and more widely used in the future. But like any other type of investment, there are always certain risks, and you should only invest the money you are prepared to lose.
Very detailed article introducing to cryptocurrencies. Good work!